Consensus Cloud Solutions, Inc. (CCSI) Earnings Call Transcript & Summary

Hi. I'm Destiny Jackson. I'm on the health care technology and distribution team here at JPMorgan, and we are thrilled to have Consensus Cloud Solutions here with us today. Here, we have CEO, Scott Turicchi; SVP of Finance, Adam Varon; and CRO, Johnny Hecker. So we'll begin with a brief presentation followed by Q&A. So with that, I'll hand it over to Scott.

Thank you, Destiny, and thank you to JPMorgan for inviting us. As Destiny mentioned, we'll go through a couple of handful of slides because not everyone may be familiar with our company is, we're still relatively new in the public markets, having spun out of a former parent known as J2 Global at the time, a little over 2 years ago. And that's all the legal stuff there for those in the room. Happy to address any of those. As Destiny mentioned, with me today is Johnny Hecker, our Chief Revenue Officer. He joined the company for the second time about 16 months ago. And so, all revenue runs through him. And then Adam is our SVP of Finance. He'll be addressing at a very high level, the financial profile of the company and particularly our debt structure and actions we're taking to reduce debt over the next several years. So in terms of the mission and what it is we really do, we move really important, primarily in the health care space, but not exclusively information around the networks. And so, our goal is to be that trusted global source for, not just the movement of the information, but it's transformation and enhancement. And some of this will become clear as Johnny goes through some of the products, particularly products like Clarity. So, this slide is an amalgamation of sort of where we come from on the right-hand side and are offering service sets and what makes them important on the left-hand side. So we do, and we've been doing for a number of years, providing through a variety of services, best-known for our cloud fax platform, generally under the brand of eFax, but not exclusively, the movement of important information. And our roots really started in other regulated industries, primarily the legal industry and the finance industry broadly defined, many different elements in the finance. So that's where our roots came from. We began to approach the health care space really about 6 years ago from a technology standpoint and about 4.5, 5 years ago from a go-to-market standpoint. So we like these regulated industries where security and data privacy is highly valued, also, where real-time communications is important. So high speed, reliable and to be trusted because of the nature of the underlying information is either contractual or it is very important in terms of the care of the patient. As a result, we have services that are not only HIPAA-compliant, but our facts and now I'm proud to announce our digital signature are HITRUST certified. We also have regional data sovereignty and our FedRAMP High certification is in progress and expected in the first quarter of this year. We also have a stream of revenue, which we refer to as a small office/home office or the SoHo. Those are generally individuals. We'll talk a little bit about the differentiation between what we call our corporate channel of revenue, which is where most of our health care activity takes place versus the SoHo, which is a very broad base of individual users that cut across every kind of industry you can imagine within our economy. Now, as I mentioned on the right-hand side, our roots are in the cloud fax space. So in 2010, we were primarily selling almost exclusively cloud fax under the brand, eFax Corporate and eFax. As we started to look at the challenges in the health care space for the movement of information and the lack of interoperability, we came up with a road map and developed several new services. I'll touch on them very briefly because Johnny is going to go into greater detail. But Unite is a bundled service that takes several HIPAA-compliant protocols and bundles them together so that the client has the choice to choose the protocol that is most appropriate for the communication of either that document or that information. jSign was designed to be part of the workflow in the health care system. And as I just mentioned, it has become HITRUST certified. It is a digital signature. Clarity is an extraction technology. Fax is an image. It's not the only kind of image that is passed around in the health care sector, but it is one that is most predominant. We all like to have structured data. So Clarity, as a platform, allows the documents to be read and for data to be extracted. We have 2 specific applications that we sell today, one is for prior authorizations and one is for clinical documentation. Harmony is a little bit further out in the future, but it's the amalgamation of these technologies that allows us really to be at the center of communications within health care and allow any kind of document -- information to come in, in any format, transform it into the format the recipient would like and then send it out. That's to come. There are pieces of that that are actually in beta right now, but the full release of Harmony is still out in the future. We've invested about $26 million in the interoperable solutions just over the last, really, 3 years. A little bit more than half of that is organic. The other piece was an M&A deal we did in February of '22. 60% of our corporate revenues is health care. 75% of our new wins are health care and 70% of our bookings are in this interoperable area. We service over 2,000 enterprise organizations. Although as Johnny is going to show you, we cover the individual customer all the way up through the enterprise. However, we're becoming more and more focused over time on the medium to large enterprise and strategic customer, agencies of the federal government, state government, et cetera. As I just mentioned, 75% of our new sales come from the health care sector. Our business model is one of a subscription model. Now, depending on where we are in the continuum, it is either more or less fixed versus variable. Think of smaller customers having a very high fixed component, very little of the revenue stream comes from their underlying usage. As you move up and you go to the very largest accounts, it inverts, where substantially, if not all the revenue comes from the actual traffic that is being processed and very little, if any, is fixed. 26% of our bookings come from the advanced products. So we're showing some traction in those interoperable solutions that are outside of the core fax space, been servicing the corporate marketplace for 20 years. And because of the subscription-based model, it also helps very much with our corporate revenue retention, which is right around 100%. I'll now invite Johnny to come up, and he'll take you on a deeper dive through the history of the company and our services.

Yes. Thank you, Scott, and hello, everyone. I'm going to take you through probably 3 slides, focusing on the one hand on the market, and our interoperable solutions, our products and then also our go-to-market approach and our customer continuum, as Scott has mentioned. On this slide, you really see -- and I'm going to start at the bottom here, you see a time line of the 21st Century Cures Act and how it develops into the TEFCA framework that is now being implemented. We're often asked about QHINs and how all of these things behave and impact our business. You can see this discussion has been going on for quite a few years, and it continues to go on. In my humble opinion, it's a very academic discussion because what we actually see in the market is fax volume is continuing to grow. Other protocols are picking up as well, but they're not replacing what we're offering. So it's actually overall communication volume is increasing among all the players. The players as we view the market here on the top left of this slide, is not only providers. Oftentimes, you have health care IT companies that deliver services very specific for one segment of the health care industry. For us, the health care industry is a lot broader. It's providers, it's physicians, but it's also pharma Rx, right? It's payers. And oftentimes, we have, let's call them, channel partners like other health care IT companies that service those specific health care players that we also include in that larger mix. And they all have the need for interoperability to communicate and exchange documents. These documents on the right side, you can see what we call the use cases are, on the one hand, referrals, but it can also be claims, prior authorization, pharmacy communication, results, diagnostics, lab results, all those kind of things, it's all about larger record sharing. Now, let me take you through the product suite in a little bit more detail. Again, starting at the bottom of the slide, you see eFax Corporate. And eFax is really, by far, still the largest contributor to our revenue to our top line. We're selling a lot of facts. We're providing a lot of these services, and it's still growing significantly in volume. In the late teens, when we started to focus more on the health care industry, we looked at this product and said, "Well, what are we doing with it and what are our customers doing with the documents that they're receiving." And we said, we wanted to extend that delivery mechanism and go deeper into their workflows. So we've added more health care-specific services and products to our just basic fax services at the beginning. The first one was really Unite, which is -- and Scott has spoken a little bit about the protocols that it serves, but it's a workflow tool for smaller clinics, smaller physician offices where they can, on the one hand, use all of those interoperable solutions, but they also have a little bit of a smoother way of handling the fax as it can integrate with an EHR. So it's a more health care-specific user interface and product. And we added as the next step, a product we call jSign, which has now, as Scott said, been HITRUST certified, and it's the only in the first HITRUST certified e-signature solution in the market, very specifically for that vertical, which is a digitally e-signature solution. So a lot of times, doctors have to sign documents. We don't know exactly what the percentage is that they have to sign, but we think it's more than half of the documents that they receive and send, need some kind of signature. So that is why we have positioned this product and we're integrating and bundling that more and more with our existing product suite. In 2023 or late 2022 and 2023, we really officially launched the Clarity platform, which, on the one hand, and we're going to speak a little about AI probably later on, but on the one hand, it's an AI application that extracts data and turns these unstructured really images that what a fax is and extract certain pieces into structured data, so it can be processed more easily and faster within the provider's environment or a payer's environment, depending on what application you use, but it's really also a way of bridging these technologies, and it's true interoperability. So we're not forcing anyone with any -- or we're not trying to incentivize anyone with payments or we're forcing them by applying a certain technology. What we're really doing is, we're providing these services. So these 2 sides of a communication can adopt at the pace that they want to adopt to a new technology. All of this will eventually come together in what we call our platform, Harmony, where then providers or whoever is part of our network, whoever has a node in our network can actually connect to and then use these services on a per use cases as they need it. But that is a vision that is what we're working on. We're having the first POC out there where we're actually having a customer who is receiving faxes. We're turning that into a direct secure message and deliver it to the other side is direct secure message. So it's the first POC of this transition that has gone live. On this slide, and I can talk for an hour about this, but I'm going to try to keep it short. We're showing what we call our continuum of customers. It's really our go-to-market approach. So the analysts and to our investors, we still report 2 business streams. One is the SoHo business and the other one is the Corporate business. And in the past, and we did a realignment of our entire go-to-market earlier in 2023 in late Q1 and early Q2. But in the past, we really also had almost different business units internally on our go-to-market. So we had a marketing team specifically for SoHo and a market team very specifically focused on Corporate. Our sales teams and our sales channels were completely separated. But what we noticed was that customers are not using those sales channels anymore. They're actually moving from the corporate space into e-commerce and want to buy our products online, even though they're corporate customers. The same thing happened to us. We had a very focused SMB inside sales team that was like a call center, inbound taking orders and more in the area of 40, 50 up to like 200, maybe 300 ARPA. And we noticed that larger customers were calling into that sales line as well and buying the service at multiple thousand dollars a month, and we saw customers don't have the need for us to travel and during COVID, it wasn't even possible, right? So the procurement processes and the buying motion of our customers evolved and changed, and we had to adjust our go-to-market to meet them how they want to buy the product. So the way we set our go-to-market up is, on the one hand, we have an e-commerce channel, where since 2023, we launched that in late 2023 with our first corporate product on the e-commerce channel, we're now also providing these services online to our corporate customers, and we're going to extend that journey throughout 2024 and offer more higher -- more sophisticated, more secure and higher-priced product on our e-commerce channel. The SMB and the -- and what we call here, the large accounts are really coming more and more together, which is our inside sales team. It has a portion of field sales to it where needed, but it's growing more together on that and then we've carved out a named account list of our most strategic and largest customers some of them, a few hundred thousand dollars per year up into millions of dollars per year that they generate revenue with us and the Federal government is in that dedicated sales team for their strategic accounts. Now, why is this important? Because on all of the things that you see on the left-hand side, these different customer groups behave differently. On the sales motion, on the lead sources, very much so in the sales cycle, right? The online customer, it's one click and they basically bought the product. It's a few seconds that they buy it. The SMB has a sales cycle of 1 to 2 weeks. But then once you get into the large accounts or strategic accounts, oftentimes, they're RFPs, RFIs involved, sales cycle can be many months up to years. And the same thing on what you see on the ramp to revenue cycle, an online customer starts using the service immediately, while these other customers might take weeks, months, sometimes years to ramp. As we can see with the example of the VA, there was a contract or a deal that we worked on for 2.5 years until we closed it. And ever since we've been ramping it, it's been ramping. We're rolling it out, but it's a multiyear process to actually roll out our service into the entire VA. Maybe one last thing on this slide that I want to talk to before I hand over to Adam, is the layers of opportunity. As we're deploying and launching more and more services and products and our interoperability, I think on the very low end, there is usually, they're usually a single-product customer, right? They buy the fax services, what they use, they buy jSign online, this is what they use as their signature solution. But as we go up market and these customers become bigger, we have more opportunity to upsell more of a single service because they might have multi-locations as they get bigger, they go through M&A. So we're trying to replace existing solutions that come in for mergers and those kind of things. And we can also cross-sell. This is where Clarity becomes a topic. This is where we can bundle products, and this is where we will eventually bring those customers on the Harmony platform. This was a little bit of an overview of our go-to-market. And with that, I'll hand it over to Adam.

Thank you, Johnny. All right. I'm going to do a quick overview of our financial profile. I'll be talking about a couple of different things with regard to our debt structure, as well as cash and cash -- free cash flow. Since we're in a quiet period, we'll be talking about through Q3 of 2023, either on an LTM basis or a year-to-date basis. From our reporting in Q3, we had a record cash balance of $156 million roughly. That's versus about $104 million the prior year and comparable quarter. Our excess cash is invested in money market funds, earning the going rate, and we earned about $1.6 million in the quarter on our money. When it comes to free cash flow, Q3 was a record post-spin full fiscal quarter, about $50 million in free cash flow versus $29.8 million, roughly $30 million in the prior year's quarter of Q3 2022. That's with an increase in CapEx as well of $2.7 million. I will note that Q1 and Q3 are high earning free cash flow quarters because we don't have our debt interest payment, which is in Q2 and Q4 in April and October, respectively. When we look at this on a year-to-date basis in Q3 of 2023, we're at about $83 million and change versus the prior year where we were at about $68.2 million, again, with an increase in CapEx to $28.7 million from $21.1 million. Moving on to an overview of 3 years' worth of revenue. We have '21 versus '22 and '22 versus the LTM Q3 of 2023, so the last 12 months. You can see that we've broken it out between SoHo and Corporate. And really, what's happening is, our growth has slowed in Corporate, you can see that amid slower corporate decision cycles, particularly in health care, how we've articulated in our earnings calls over the last several quarters. The decision cycles have slowed due to labor and IT resources within our largest installations and it takes a longer time to ramp, as Johnny had mentioned. So our year-over-year in '21 to '22 for Corporate went from roughly $170 million to $192 million and change, which was like a 13.2% increase. And that has slowed to 3% from 2022, $192 million to $198 million in the LTM Q3 2023 period. So, the takeaway here is, we still are experiencing a strong pipeline in the Corporate channel. We have strong cash generation, but our operational performance is impacted by the slow decision cycles and delayed implementations. Going to the final slide. This talks about our leverage, leverage ratios. In the spin-off transaction, we were levered by $805 million, 2 tranches, 5-year non-callable 2 years, which is now in the callable period because that's October of 2023. I'm sorry, it's executable, I should say, $305 million. Then we have 7-year notes, non-call 5 years at $500 million for a total of $805 million. With a $156 million roughly in cash, our net debt is about $649 million. So when you look at the credit stats of the LTM adjusted EBITDA of $188 million at 9/30, 2023, our gross debt to EBITDA leverage ratio was 4.27x and our net is 3.44x. Now, we have announced a $300 million bond repurchase program that was authorized by the Board. It was in our release for Q3. And the cash generation in the future, we're going to manage our EBITDA. I know it's probably a question that's going to come, but managing EBITDA and free cash flow to maximize the potential to delever to roughly a guided area, we would like to be at like 2 -- between 2x and 3x levered. So that bond repurchase program and the company's cash generation will definitely favorably affect our leverage in the future. With that, I will hand it to Destiny.

Okay. So I'd like to begin with the demand environment. So as we follow recent commentary from the 4 publicly traded hospital systems, it seems that labor costs are normalizing and operating margins are improving. However, this hasn't yet translated to health care IT demand. So can you speak about -- a bit about the demand environment and what you're seeing there?

Yes. I think a couple of things. One is, as Johnny pointed out, our go-to-market is broader than just, say, the provider category. So we see things in different pockets. But I think the premise of your question is correct. We've been saying for about 4 or 5 quarters now that the tight labor market has extended decision-making cycles and implementation. That remains true. We've seen some relief in that in the more recent past. But it's not yet clear how that's translating into an accelerated decision-making time frame. And what I would just note to everybody is, as Johnny pointed out in that slide where there's the continuum, particularly on the larger accounts, even if they were to be won today, they would probably have very modest impact on '24 revenues. That would be more of a '25 event because it takes even on an expedited viewpoint, a few weeks to sign those contracts because at the very large end, they tend to be customized. They're not off-the-shelf. And then there's the implementation. And the implementation is very hard to size up. He had a very wide range in there because implementation is a function of how many different physical facilities you have, what is the infrastructure you have, how is the service being integrated into them, what various APIs do you need? So there's not a generic answer that you can say, "Well, if you're fully staffed, it will only take 3 months?" If you're a partially staffed, it will take 6? If you're not staff, who knows? It's not that simple, each one is somewhat bespoke. But I would say that it has become better from a pipeline bill in a conversation than it was 6 months ago. But we're still looking for more, what I'll call, more relief because the labor market still remains fairly tight. We know the margins while better, are still not where they would ideally like to be. And we also know that they're allocating some of those marginal dollars more to point of care than they are to IT. So these are all kind of the factors that we take into play, specifically as it relates to the hospitals.

So going off of that, can you talk about your go-to-market strategy with health care customers as they navigate this challenging environment?

Yes. I'll turn it over to Johnny because that's his job.

Yes. Yes. And I've talked a little bit about it in my presentation. Like I said, we're really dividing up that health care market into the segment's providers. And then we have pharma Rx, we have the payers very important for us as well. And then health care IT is a channel and everything that is in-between. So there's companies that are very specialized in revenue cycle management or just prior authorization clearing houses and those kind of. So we're segmenting those and we're approaching them differently. We have one team, for example, that's very focused just on providers because they just function differently than payers. Payers are insurance companies, right? They behave like a financial services institution, a provider behaves very differently. And then IT, health care IT or EHR vendors, for example, they -- I mean, they're IT companies, right? So we talk to different constituents, different buying persona in those customers. So we're making sure that we address them separately in our marketing and our go-to-market approach, but also with our sales teams. And then the other thing that I showed on the customer continuum slide is, we have very different sizes of customers, right? So we have a ton of customers that are single physician offices, physical therapists, right? Like very -- like just like yoga teachers in that area, all kinds of stuff there are single SoHo customers, SMB, maybe 2, 3 locations, dentist offices, those kind of things. And then it goes all the way through smaller clinics, smaller hospitals, all the way up to that large like academic medical centers, integrated networks and the largest payers that are presenting here as well. So there's a lot of customers here at the conference, but this is really our go-to-market approach.

So there's multiple on the market approach to be clear because they're different end customers. And I think that's -- it's one of the things that differentiates us from other companies is, to Johnny's point, when you get debated whether it's good or bad, they tend to focus either on a specific protocol or a specific end user customer. A lot of it is, we inherited, even though our focus on health care was refined and the investment was accelerated in the late teens. And certainly, that's been true post spin of October of '21, we actually had health care customers predating that. I call them the accidental customers. There were customers that would come in, and it was true of other sectors as well that we had not customized a solution for a focused on. But yet they came knocking on our door and we were able to cut a deal and service them. And so, you, over time, ended up with all of these different end points in different pieces or different industries of the health care sector. That's kind of how we ended up where we are today and why we're not a company that is only focused on hospitals or only focused on payers.

Okay. So we spoke a bit about AI and interoperability in our fireside chat early last year, which I really enjoyed. So since then, have you seen any new developments in AI and health care industry?

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